SEC backs two options to control money funds; White floats combo

One would let value of some money funds float, another would impose redemptions

Seeking to enact the money market fund reform that eluded her predecessor, Securities and Exchange Commission Chairman Mary Jo White today floated a two-part plan that was unanimously approved by her fellow commissioners, including the three who voted down last fall's proposal from then-chairman Mary Schapiro.

One of Ms. White's proposals would require the prime institutional funds, considered the riskiest money markets, to have net asset values that fluctuate daily with market conditions rather than maintain a stable $1 share price. Government and retail money market funds could continue to use a $1 NAV.

Prime institutional funds comprise about 37% of the money-fund market, according to SEC staff. They represent about $1 trillion of the approximately $2.6 trillion in money fund assets.

Ms. White's second proposal would maintain a stable NAV for funds but impose restrictions on redemptions and charge withdrawal fees during financial market stress, according to an agency fact sheet. Under this approach, if the fund's weekly liquid assets fall below 15% of its total assets, the fund would be required to impose a 2% redemption fee unless the fund's board determined that such a fee would be harmful to the fund. The board also could set the fee at a lower rate

In addition, once a fund's assets fall below the liquidity threshold, its board could temporarily suspend redemptions for up to 30 days.

The two alternatives could be combined — with the floating NAV applying to prime institutional funds and the gate-and-liquidity requirements imposed on all other non-government money funds. Indeed, in her prepared remarks, Ms. White stressed that she was interested in hearing from interested parties and the public about the idea of combining the two proposals into one comprehensive rule.

“A lot of advisers have clients in both kinds of shares,” Mr. Thompson said. “It's going to make their analysis of the suitability of money market shares for their clients that much more complex.”

Even though the SEC's money-fund proposal is a long way from being finalized, it does send a signal that the government is not inclined to step in and bail out funds that collapse. That means that advisers have to treat them like other assets that fluctuate in value, according to Mr. Thompson.

“They're going to have to assess the risk of money funds just as they do with other equities,” Mr. Thompson said.

The leader of one of the biggest money-fund companies said that he backs a gate-and-fee mechanism over a floating NAV.

J. Christopher Donahue, president and chief executive of Federated Investors Inc., told a Keefe Bruyette & Woods conference in New York on Wednesday that a floating NAV would not stop heavy redemptions.

“[Gate-and-fee] does all the things appropos of a run that you want done,” Mr. Donahue said.

Imposing a floating NAV on prime institutional funds would undermine a money-fund characteristic that draws investors – a stable value of $1, he said.

“If there is a floating NAV on prime institutional money funds....then those people are going to be out of the money fund,” Mr. Donahue said. “They're exit stage right.”

He asserted that tax and other ramifications of a variable NAV would cause investors to switch to government funds, large banks or private funds.

SEC staff, however, said that a floating NAV would not cause a tax burden.

Jay Baris, a partner at Morrison Foerster LLP, said that investors may abandon retail funds, too, because of the withdrawal ceiling under the SEC definition.

“You could see the money flowing out, if a customer needs the ability to redeem more than $1 million in a day,” Mr. Baris said.

Ms. White said the proposals are designed to prevent the precipitous withdrawal from money funds — such as that which happened in 2008 when the Reserve Primary Fund, the industry's first money market fund, fell below its $1 per share NAV, or “broke the buck.” That led to a major disruption in the credit market and contributed to the broader financial crisis.

“Our goal is to implement an effective reform that decreases the susceptibility of money market funds to run risk and prevents money market fund events similar to those that occurred in 2008 from repeating themselves,” Ms. White said at an SEC meeting today.

Ms. White said the SEC is zeroing in on the highest money fund risk.

“This floating NAV proposal specifically targets the funds where the problems during the financial crisis occurred: institutional, prime money market funds,” she said. “Retail and government money market funds — which have not historically faced runs, even in the worst of times — would be exempt from the proposed floating NAV requirement.”

The agency defines a government fund as one that holds 80% of its assets in cash, government securities or repurchase agreements collateralized with government debt. A retail fund is one that limits each shareholder's redemption to no more than $1 million daily.

The money fund proposal will be open to a 90-day comment period after it is published in the Federal Register. After reviewing the feedback, the SEC might revise the proposal. Publishing a final rule would require a majority vote of the five-member commission.

The unanimous agreement among the commissioners represents a marked change from August, when three SEC members — Luis Aguilar, Daniel Gallagher and Troy Paredes — voted against moving ahead with a money fund proposal put forward by Ms. Schapiro.

She had made money-fund reform a signature issue, saying that runs represent a systemic risk to the financial system. Her plan included a floating NAV for all money funds, as well as a proposal to implement capital buffers.

Over the past several months, the SEC, under short-term Chairman Elisse Walter, who remains a commissioner, and Ms. White, reworked the proposal to answer concerns raised by the three opposing commissioners.

“The process leading to today's proposal has been a refreshing and inclusive process and stands in direct contrast to the previous process,” Mr. Aguilar said.

Mr. Gallagher praised the 700-page proposal for offering a comprehensive discussion of a floating NAV and the other recommendations.

“Today's proposal not only tees up hard issues but also tries to solve them,” he said. “We are light years ahead of last year's proposal.”

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